Neal: Cutting the Sales Tax Would Be a Better Idea

September 17, 2012

For release Sept. 19 and thereafter (660 words)

by Andrea Neal

At 3.4 percent, Indiana’s personal income tax is one of the nation’s lowest. A half dozen states, including Texas and Florida, don’t charge income tax at all; 41 states impose a rate higher than Indiana’s.

At 7 percent, the Indiana sales tax ties for second highest with four other states. The only higher one is California’s at 7.25 percent.

Indiana is one of just a few states that charge a sales tax for gasoline on top of an excise tax. Our excise tax is 18 cents a gallon – relatively low – and doesn’t change as gas prices fluctuate. Its revenues are used to pay for highways, roads and other infrastructure maintenance. In contrast, the 7 percent sales taxgoes to the general fund. It brings in more revenues to the state as gas prices go up.

This data is important to remember as Hoosiers consider the campaign tax proposals of our governor candidates, Democrat John Gregg and Republican Mike Pence.

Mr. Gregg wants to permanently eliminate the state sales tax on gas at a savings of $540 million a year. He figures that rising gas prices are pinching family budgets enough at the pump, and they could use the break.

Mr. Pence suggests cutting the state individual income tax by 10 percent, to 3.06 percent, which would save Indiana taxpayers $530 million a year. He says that’s a good way to give their money back to taxpayers when the state is collecting more than it needs.

Both proposals seem off the mark if the goal is to deliver across-the-board relief.

An impact study by the Institute on Taxation and Economic Policy in Washington D.C. concluded that 12 percent of Hoosiers would “see no benefit” from the Pence plan. Those are lower-income families who don’t pay income taxes at all, but do pay sales taxes on most things they buy. That includes groceries and medicine excluded.

Also, an income tax cut at the state level results, somewhat ironically, in Hoosiers sending more money to Washington. That’s because taxpayers who itemize on their federal returns can deduct state and local income taxes. According to the Institute, Mr. Pence’s plan would erase $50 million in itemized deductions.

Mr. Gregg’s plan suffers from a similar flaw. It would give immediate relief to motorists, yet many of the lowest-income Hoosiers don’t own cars and would get no benefit. Plus it gives unwarranted benefit to all those tourists passing through Indiana on their way to elsewhere.

This seems especially shortsighted at a time when fiscal experts are warning of dwindling resources to pay for upkeep of road, bridge, sewer and utility networks. With money about to run out from Gov. Mitch Daniels’ Major Moves initiative, Indiana will have to look for new funding for infrastructure. Some lawmakers have even suggested diverting gas sales tax money from the general fund to highway and bridge maintenance.

A compromise between the Gregg and Pence plans would be to roll back the sales tax to 6.5 percent. This would benefit all Hoosiers, cost about the same, help reverse Indiana’s reputation as a high sales tax state, and bring the mix of taxes into healthier proportion.

As noted in the recent report, “Policy Choices for Indiana’s Future,” “Indiana’s seven percent sales tax is high, and proceeds from the sales tax are now the largest component of state revenue” at 47 percent.

The report, a white paper prepared by the Indiana University Public Policy Institute, also recommended including services – not just goods — in the sales tax base. Although controversial, that idea would allow the state to reduce the sales tax further.

Indiana’s tax climate is rated healthy by most economists, and our individual tax burden – as ranked by the Tax Foundation – is 25th, smack dab in the middle.

Mr. Gregg and Mr. Pence are both right when they say it could be better still. By cutting the sales tax, they could achieve their goals and nudge Indiana closer to the median. The top spots in a tax ranking are never a good place to be.

Andrea Neal is adjunct scholar with the Indiana Policy Review Foundation. Contact her at aneal@inpolicy.org. Nothing written here is to be construed as reflecting the views of the foundation or as an attempt to aid or hinder the passage of any bill before the legislature or to further any political campaign.

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